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The recent allegations of misreporting and regulatory scrutiny have raised serious concerns about the audit quality of all U.S. listed Chinese companies. Because the PCAOB is unable to inspect the audit work papers of Chinese audit firms, investors might be apprehensive about the audit quality of Chinese companies. The SEC’s investigation of Chinese “reverse mergers” added to the controversy surrounding Chinese companies. A critical question is whether the much publicized financial reporting problems or audit quality concerns are restricted to Chinese reverse mergers, or whether they are more systematic problems describing a larger population of Chinese companies including American Depositary Receipts (ADRs), which is the predominant form of cross listing foreign shares in the U.S.

In this study, we examine the audits of Chinese ADR engagements, whether their auditors are likely to charge more, are likely to expend greater audit effort, whether Chinese ADRs are less likely to restate, whether they are more prone to litigation risk, and whether the market discounts Chinese ADRs relative to other ADRs or Chinese reverse mergers. Read more